WHY DO FIRMS BUYBACK THEIR SHARES? AN ANALYSIS OF

OPEN MARKET SHARE REACQUISITIONS BY U.K. FIRMS

Dennis Oswald† and Steven Young‡

First version: August 2002

This version: November 2002

†London Business School, Regent’s Park, London, NW1 4SA, UK. Tel. ++44 (0) 207 262 5050. Email doswald@london.edu. ‡Department of Accounting & Finance, Lancaster University, Lancaster, LA1 4YX, UK. Tel. ++ 44 (0) 1524 594242. Email s.young@lancaster.ac.uk. We are grateful to John O’Hanlon, Ken Peasnell and seminar participants at Cardiff, Lancaster, London Business School, Swansea, the 2002 Annual Meeting of the British Accounting Association and the 2002 European Financial Management Association Annual Meeting for helpful comments and suggestions. We also acknowledge excellent research assistance provided by Anuradha Jayaraman and Jennifer Johnson. Financial support was provided by the Economic and Social Research Council (contract #R000223516) and London Business School.

ABSTRACT

WHY DO FIRMS BUYBACK THEIR SHARES? AN ANALYSIS OF OPEN

MARKET SHARE REACQUISITIONS BY U.K. FIRMS

This paper explores the determinants of share reacquisitions by U.K. firms over the

period January 1995 to December 2000. We find that the repurchases appear to be

used to distribute surplus cash and exploit perceived underpricing. Further analysis

reveals that the surplus cash effect is more pronounced for firms characterised by low

leverage and a limited investment opportunity set. Limited evidence also indicates

that the association between share reacquisitions and surplus cash is stronger in the

presence of poor contemporaneous share returns, consistent with the view that

distributions of excess cash are timed to create further value for shareholders.

Contrary to predictions, however, the probability that a firm distributes surplus cash

via a share repurchase is lower when the underpricing occurs in the year prior to the

repurchase.

Keywords: Share repurchases, surplus cash, underpricing

Running title: Share Repurchases in the U.K.

WHY DO FIRMS BUYBACK THEIR SHARES? AN ANALYSIS OF OPEN

MARKET SHARE REACQUISITIONS BY U.K. FIRMS

1. INTRODUCTION

Despite extensive research in the U.S., the reason why firms buy back their

shares remains the subject of considerable debate. Among the list of suggested

explanations are buying ‘cheap’ stock when managers perceive the firm is

undervalued (Ikenberry et al., 2000 and 1995; Vermaelen, 1981), distributing excess

cash (Fenn and Liang, 2001; Dittmar, 2000), adjusting capital structure (Dittmar,

2000) and funding employee share option exercises (Kahle, 2002; Dittmar, 2000).

Further, with share buybacks now becoming increasingly popular in non-U.S.

jurisdictions (Ikenberry et al., 2000: 2373), the generalisability of prior U.S. findings

to different institutional environments is also unclear (Rau and Vermaelen, 2002:

245). Accordingly, this paper examines the determinants of open market share

repurchases in the U.K. with the objective of developing a more complete

understanding of their incidence, rationale and potential shareholder wealth effects.

Share repurchase activity is currently growing at a dramatic rate in the U.K.

According to evidence presented by Rau and Vermaelen (2002) and Lasfer (2001), the

U.K. accounts for between 60% and 70% of total European repurchase announcement

activity. In one of the few studies to examine share buybacks in the U.K., Rees (1996)

reports evidence of a positive price reaction to announcements that open market

repurchases have taken place. More recently, Rau and Vermaelen (2002) examine

U.K. share repurchase activity and conclude that the form and intensity of buybacks is

primarily influenced by their tax consequences for pension funds. Oswald and Young

(2002a) re-examine Rau and Vermaelen’s (2002) findings and arrive at different

1

conclusions. Using a more comprehensive dataset, they conclude that Rau and

Vermaelen’s (2002) tax results are driven by sample selection bias. Instead, Oswald

and Young (2002a) find that repurchasing firms are characterised by poor stock

market performance in the period leading up to the buyback announcement, consistent

with the view that buybacks are driven by a perception that the firm is undervalued.

However, Oswald and Young (2002a) do not consider alternative explanations for

buybacks such as distributing excess cash or adjusting capital structure. As such, the

reasons why U.K. firms repurchase their shares remain unclear.

In this paper, we test a range of theories why firms repurchase their shares. We

focus on actual share reacquisitions (as opposed to announcements of repurchase

intentions or executions) because prior research suggests that repurchase

announcements provide a potentially poor proxy for the actual volume of shares

bought back (Ikenberry et al., 2000; Stephens and Weisbach, 1998). We restrict our

analysis to open market buybacks because self-tender offers and other off-market

repurchase methods are used only rarely in the U.K. We begin by analysing the

reasons disclosed by management for the buyback. Consistent with extant theory,

firms cite undervaluation and the desire to distribute excess cash amongst their list of

repurchase reasons. Other frequently cited reasons such as ‘improving earnings per

share’ and ‘increasing balance sheet efficiency’ are more difficult to interpret. Further,

almost one third of our sample fail to disclose any reason for the repurchase. We

conclude that management disclosures are capable of providing only limited insights

into the drivers of share repurchases.

In an attempt to shed further light on the determinants of open market share

reacquisitions, we undertake two complementary empirical analyses. First, we

compare the characteristics of repurchasers with a matched sample of

2

nonrepurchasing firms. Secondly, we model the value of shares repurchased using

only those firms that report at least one open market share reacquisition during our

sample period. Our results suggest that both the probability and value of shares

repurchased are associated with high cash holdings and a poor returns history. These

results are consistent with the view that share buybacks are used to distribute surplus

cash and exploit perceived underpricing, respectively. Further analysis reveals that the

positive link between cash holdings and repurchase probability is more pronounced

for firms with low gearing. To the extent that buybacks increase the gearing ratio, our

results suggest that concerns over the increased risk of financial distress may act as a

brake on the use of repurchases as a cash distribution mechanism. We also find that

the positive association between cash holdings and the value of shares reacquired is

stronger when investment opportunities are more limited. These results support the

view that repurchases are a response to the agency problems of surplus cash.

Besides boasting one of the highest levels of share repurchase activity of any

country outside the U.S., several additional factors make the U.K. a potentially

interesting setting in which to explore share buybacks. First, the tax and regulatory

environment in the U.K. differs in a number of important ways from that faced by

U.S. firms. This makes the U.K. an attractive setting in which to assess the

generalisability of extant U.S. findings. Secondly, the legal requirement for

companies to disclose in their published financial statements the number and cost of

all common shares repurchased during the year means that accurate measures of share

repurchase activity are readily available. In contrast, studies of U.S. buybacks are

forced to rely on potentially noisy estimates of share reacquisitions (e.g., Kahle, 2002;

Fenn and Liang, 2001; Dittmar 2000; Stephens and Weisbach 1998).

3

The remainder of the paper is organised as follows. The next section

summarises the extant literature on share repurchases. In section 3 we develop our

predictions regarding the drivers of U.K. repurchase activity and outline our research

design. Section 4 presents details of the sample and data, together with an analysis of

the reasons cited by management for share buybacks. The factors that distinguish

repurchasers from nonrepurchasers and those that explain the amount spent on

repurchases are examined in section 5. Section 6 concludes.

2. LITERATURE REVIEW

The literature on share repurchases can be classified according to two distinct

research methodologies: studies examining the market reaction to the announcement

of intentions to implement a repurchase programme and studies examining the actual

number and cost of shares bought back. The majority of extant studies adopt the

former approach. A consistent finding emerging from this body of work is that the

U.S. stock market reacts favourably to share repurchase announcements, with average

announcement-period abnormal returns ranging from 2% to 3.5% (e.g., Barth &

Kasznik, 1999; Comment and Jarrell, 1991; Lakonishok & Vermaelen, 1990;

Vermaelen, 1981). Positive market reactions to repurchase intention announcements

have also been documented for Canada (Ikenberry et al., 2000) and the U.K. (Oswald

and Young 2002a; Rau and Vermaelen, 2002).

A range of theories have been proposed and tested to explain the positive stock

market reaction to repurchase announcements. One explanation that has received

considerable attention in the literature is the signalling hypothesis. Information

asymmetry between managers and shareholders may cause a firm to be undervalued.

If insiders believe that their firm is undervalued, they may announce their intention to

4

implement a share repurchase programme to signal this fact to the market. The

signalling hypothesis predicts that market participants interpret share repurchase

announcements as evidence that the firm is underpriced, thus leading to an upward

revision in the share price (Comment and Jarrell, 1991; Vermaelen, 1981). Further,

because the likelihood of undervaluation is increasing in the level information

asymmetry, Barth and Kasznik (1999) predict and find evidence that both the

likelihood of a repurchase announcement and the resulting announcement-period

abnormal returns are positively associated with the level of information asymmetry.

An alternative explanation for the positive stock market reaction to repurchase

plan announcements is the surplus cash hypothesis which is based on the view that a

firm’s cash resources may exceed the set of value-increasing investment opportunities

available to management. Under such conditions, managers face incentives to invest

‘surplus’ cash on perquisites, empire building and other negative net present value

projects. Accordingly, shareholders of firms characterised by surplus cash and a poor

portfolio of investment opportunities face serious agency problems if management do

not distribute this excess cash (Harford, 1999; Jensen, 1986). Share repurchases

provide managers with a means of distributing excess cash to shareholders, thereby

reducing the opportunity for wasteful investment and hence increasing firm value.

Consistent with the surplus cash hypothesis, Lie (2000) reports a higher market

reaction to announcements of self-tender offers for firms with high cash holdings and

limited investment opportunities while Barth and Kasznik (1999) present evidence

that firms announcing open market share repurchase intentions are characterised by

larger cash holdings than nonannouncing firms.1

Open market repurchase plan announcements do not represent binding

commitments to repurchase shares in the future. Instead, firms are free to abandon the

5

proposed buyback at any subsequent stage, as well as deciding to repurchase more

shares than indicated in the original programme announcement. This feature raises

several concerns about using repurchase announcements to explore the motives for

share buybacks. First, studies relying on share repurchase announcements may

represent noisy tests of actual buyback activity.2 Second, to the extent that agency

costs are only reduced when a repurchase actually takes place, announcement-based

studies do not sit comfortably with the surplus cash hypothesis. Third, the costless

nature of open market repurchase announcements is inconsistent with the signalling

hypothesis, which is based on the assumption that buyback announcements are costly

signals to replicate. Fourth, several additional motives for share repurchases have

been proposed that are not necessarily expected to increase share prices at the

announcement date. These include fending off hostile takeover attempts, avoiding the

dilutive impact of share options on the per share value of outstanding stock and

adjusting the firm’s capital structure. For these reasons, recent work has begun to

focus on the aggregate number and cost of shares actually reacquired (e.g., Fenn and

Liang, 2001; Dittmar, 2000; Ikenberry et al., 2000; Stephens and Weisbach, 1998).

Oswald and Young (2002a), Ikenberry et al. (2000), Dittmar (2000) and

Stephens and Weisbach (1998) present evidence that share reacquisitions are

negatively correlated with share price performance: as prices fall, managers appear to

respond by buying more shares. This strategic trading behaviour is consistent with the

view that firms initiate repurchases when their shares are perceived as being

underpriced. As Rau and Vermaelen (2002: 250) discuss, the underpricing hypothesis

is subtly different from the signalling hypothesis because it assumes that the market’s

response to the announcement of a planned repurchase is incomplete. Consistent with

the incomplete adjustment assumption underlying the underpricing hypothesis,

6

Ikenberry et al. (1995) report positive abnormal returns for value stocks over the four-

year period following repurchase announcements.

In addition to underpricing, several studies present evidence consistent with

the prediction that share reacquisitions are motivated by a desire to distribute surplus

capital. For example, Jagannathan et al. (2000) and Stephens and Weisbach (1998)

report a positive association between share reacquisitions and cash flows, while

Dittmar (2000) documents a positive relation between reacquisitions and total cash

holdings. Further, because excess cash is most likely a problem for firms with limited

investment opportunities, Dittmar (2000) predicts and finds a strong negative

association between share reacquisitions and firms’ investment opportunity set, as

proxied by the market-to-book ratio.

While the surplus cash and underpricing hypotheses are the most prominent

explanations in the literature for share reacquisitions, other motives have also been

proposed and tested. The capital structure hypothesis predicts that repurchases are

motivated by the desire to maintain an efficient balance sheet (Dittmar, 2000). For

example, if managers believe that an optimal leverage ratio exists, repurchases may be

used by undergeared firms as a means of achieving their target leverage ratio.

Consistent with this prediction, Dittmar (2000) finds that share repurchases are

negatively associated with gearing. Moreover, if share reacquisitions are financed

with debt, they can help reduce corporate taxes and hence lower the firm’s cost of

capital (Rau and Vermaelen, 2002). However, an alternative explanation for the

negative association between share reacquisitions and leverage is that binding debt

contracts or an increased risk of financial distress may restrict the opportunity for

highly geared firms to implement buybacks.

7

Because repurchases increase the minimum price at which shares can be

purchased in the market, buybacks can be used as a part of a takeover defence strategy

designed to increase the price an acquirer will have to pay to gain control (Bagwell,

1991). Alternatively, Kahle (2002) and Barth and Kasznik (1999) cite the desire to

counter the dilutive effects of share options as an alternative motive for share

reacquisitions. Consistent with the takeover deterrence and share option hypotheses,

Dittmar (2000) reports that share reacquisitions by U.S. firms are positively associated

with both takeover likelihood and the total number of share options outstanding.

However, these associations are time-varying: the relation with takeovers is limited to

mid-1980s when the market for corporate control was at its peak while the link with

options is confined to the 1980s and 1990s when option-based compensation became

increasingly popular. Kahle (2002) provides additional evidence that firms repurchase

shares to fund employee option exercises and hence avoid earnings dilution.

3. RESEARCH DESIGN AND PREDICTIONS

This study examines share reacquisitions made by U.K. firms. We employ two

complementary approaches to isolate the drivers of actual share reacquisition activity.

First, we compare firms that make open market share reacquisitions with a control

sample of nonrepurchasing firms. Secondly, we model the value of shares repurchased

in a given year using the set of firms reporting at least one open market share

reacquisition during our sample period. Further details of these tests and their

associated predictions are outlined below.

What factors distinguish repurchasers from nonrepurchasers?

Our first set of tests involve comparing open market share repurchasers with a

time-, industry- and size-matched sample of nonrepurchasing firms. Specifically, we

8

estimate the following conditional logistic regression model relating the probability of

an open market share repurchase in time t to measures of underpricing, surplus cash,

investment opportunities, leverage and a vector of control variables:3

.

)Pr(

1,91,81,71,6

1,51,41,31,21,1,

−−−−

−−−−−

++++

∆++++=

titititi

titititititi

DISTSIZEDIVPAYLOSS

EPSHILEVCASHMTBNRETurchaseRep

γγγγ

γγγγγ (1)

All explanatory variables in equation (1) are measured at the beginning of the

repurchase year. The conditional logistic model is the appropriate method for matched

pairs data (Breslow, 1982). It involves fitting a standard logistic regression to a

constant response, where the model has no intercept and all explanatory variables are

equal to the difference between each case–control matched pair. Accordingly, the

dependent variable in equation (1) takes the value of one for each of the 365 matched

pairs in our sample while all explanatory variables are defined as the difference

between the ith pairwise combination. For simplicity, the following discussion refers

to all explanatory variables prior to differencing.

NRET is our proxy for underpricing and is defined as one if the market-

adjusted return measured over the fiscal year prior to the repurchase year is negative

and zero otherwise.4 Dittmar (2000) argues that a poor returns history is a possible

indicator of underpricing. Consistent with this prediction, Ikenberry et al. (1995),

Comment and Jarrell (1991) and Vermaelen (1981) document negative abnormal

returns in the months preceding a repurchase announcement, while Ikenberry et al.

(2000) and Stephens and Weisbach (1998) find that share reacquisitions and prior

stock returns are negatively associated. We predict that NRET will be negatively

associated with the likelihood that a firm repurchases its shares.5

9

MTB is the unlevered market-to-book ratio. It is predicted to be negatively

associated with the probability of a share repurchase for several reasons. First, firms

with low market-to-book ratios are more likely to be underpriced (Dittmar, 2000;

Ikenberry et al., 1995; Lakonishok et al., 1994). Secondly, to the extent that the

market-to-book ratio is negatively correlated with firms’ investment opportunities, the

agency problems of excess cash are likely to be more acute for low market-to-book

firms (Fenn and Liang, 2001; Lie, 2000; Lang and Litzenberger, 1989). However,

prior research also uses the market-to-book ratio as a proxy for information

asymmetry. According to this view, the probability of a share repurchase is expected

to be positively associated with MTB because high market-to-book firms are

predicted to face greater information asymmetry (Barth and Kasznik, 1999). The

information asymmetry effect confounds the negative association between MTB and

the likelihood of a buyback predicted by the underpricing and surplus cash hypotheses

and could, if strong enough, result in MTB being positively associated with

repurchase likelihood. The precise nature of the association between share repurchase

activity and the market-to-book ratio is therefore an empirical issue on which this

paper aims to shed light.

We include CASH in equation (1) as a direct measure of surplus cash. We

define CASH as the ratio of cash and cash equivalents to total assets. The surplus cash

hypothesis predicts that CASH will be positively associated with the likelihood of a

share repurchase. Equation (1) also includes HILEV, an indicator variable defined as

one if leverage is above the median for the pooled sample and zero otherwise. If firms

initiate buybacks when gearing levels undershoot their target leverage ratio, HILEV

will be negatively associated with the likelihood of a share repurchase. To control for

the negative association between leverage and excess cash we follow Dittmar (2000)

10

and measure gearing as the ratio of net debt (debt minus cash and cash equivalents) to

non-cash assets.

Equation (1) also includes several control variables. Analysis of management

disclosures (see Section 4) reveals that many firms in our sample cite the desire to

increase earnings per share (EPS) as a motivation for the repurchase. One explanation

for the concern with EPS is that managers believe analysts and investors fixate on

EPS growth for valuation purposes (The Times, January 10 1998: 53). We therefore

include a measure of earnings per share growth (∆EPS) in equation (1). However, we

do not predict the sign of the relation between ∆EPS and repurchase likelihood. On

the one hand, if firms with poor prior-period EPS performance are using share

repurchases in an attempt to boost (or signal an increase in) future EPS, ∆EPS will be

negatively associated with the likelihood of a repurchase. Alternatively, if firms with

high EPS growth in prior-periods are using repurchases as a means of sustaining (or

signalling) further growth in the future, ∆EPS will be positively associated with the

likelihood of a repurchase.

LOSS is an indicator variable taking the value of one if prior-year reported

earnings are negative and zero otherwise and is intended to proxy for the absence of

surplus advance corporation tax (ACT) against which to offset the ACT arising on a

share repurchase.6 All else equal, firms lacking surplus ACT capacity are less likely to

initiate a share repurchase because doing so will generate an additional ACT liability.

We therefore predict that LOSS will be negatively related to the probability of a share

repurchase. The dividend payout ratio (DIVPAY) is included to control for the

possible interaction between dividends and share repurchases. DIVPAY is defined as

dividends paid divided by reported earnings.7 We do not predict the sign of the

coefficient on DIVPAY because if firms view dividends and share repurchases as

11

substitutes the relation will be negative whereas if firms use both devices as

complimentary distribution mechanisms it will be positive. Firm size (SIZE) is

included to control for any residual size differences not captured by our matching

procedure. SIZE is measured as the natural log of total assets. Finally, DIST is an

indicator variable proxying for the existence of distributable reserves. Under U.K.

company law, firms are only allowed to fund share repurchases out of distributable

reserves. We define DIST as one if total shareholder reserves are positive and zero

otherwise and predict that this variable will be positively associated with the

probability of a share repurchase.

While prior studies have examined the independent effect of factors such as

underpricing, surplus cash and leverage on the reacquisition decision, the interaction

between these effects has been largely overlooked. Nevertheless, such interactions are

expected to play a potentially important role in explaining repurchase decisions. For

example, regardless of the specific driving force underlying the decision to repurchase

its shares, management are more likely to make reacquisitions when their stock

appears ‘cheap’, all else equal. In other words, even if underpricing is not the primary

driver of share reacquisitions, it may still play an indirect role through its impact on

buyback timing. Consistent with this view, Lie (2000) presents evidence that the

market reaction to repurchase plan announcements is larger for firms with surplus

cash holdings when their share price appears undervalued.8 To capture this effect, we

extend equation (1) to include the CASH×NRET interaction term and test whether it

is positively related to the likelihood of a share reacquisition.

In addition to its interaction with underpricing, surplus cash may also interact

with the investment opportunity set and gearing. Specifically, to the extent that the

surplus cash hypothesis represents the joint test that firms have high cash holdings and

12

a shortage of profitable investment opportunities, the likelihood of a firm reacquiring

shares to distribute excess cash is expected to increase as the availability of alternative

investment opportunities declines. Results reported by Fenn and Liang (20001) and

Lie (2000) support the prediction that the association between cash payouts and cash

holdings is stronger for firms with limited investment opportunities. Similarly, since

repurchases increase leverage, the likelihood of a firm reacquiring shares to distribute

excess cash is expected to be lower for firms that are already highly geared. This is

because further increases in leverage resulting from the repurchase could increase the

probability of financial distress. Based on the above arguments, we further expand

equation (1) to include the CASH×MTB and CASH×HILEV interaction terms. We

predict that both two-way interaction terms will be negatively associated with the

probability of a share reacquisition.

What factors explain the amount spent on repurchases?

As an alternative way of shedding light on the drivers of share repurchases we

model the amount firms spend on buybacks in each year during our sample window.

To the extent that each firm serves as its own control, this approach helps to overcome

the correlated omitted variable problem that can render the results of matched-pair

tests potentially difficult to interpret. In addition, the amount spent on buybacks

contains important information ignored by our matched-pairs tests. Accordingly, we

estimate the following OLS regression using an unbalanced panel comprising all

available firm-year observations for firms making at least one open market share

repurchase during our sample period:

.

)ln(

,,101,91,81,71,6

1,51,41,31,2,10,

tjtjtjtjtjtj

tjtjtjtjtjtj

ACTPAYOUTDISTLOSSEPS

HILEVCASHMTBNRETNRETCOST

εδδδδδ

δδδδδδ

+++++∆+

+++++=

−−−−

−−−−

(2)

13

COST is equal to zero for the jth firm in years where no shares are acquired;

otherwise it equals the aggregate cost of shares repurchased during fiscal year t scaled

by total assets at the beginning of year t. Because COST is lower bounded at zero, we

employ a logarithmic transformation to limit the risk of specification bias.9 The vector

of explanatory variables is identical to that in equation (1) with two exceptions. First,

we include a measure of contemporaneous share price performance (NRETt) in

equation (2) as a more timely underpricing proxy for firms that acquire shares towards

the end year t. Secondly, Oswald and Young (2002b) document a dramatic increase in

buyback activity following the abolition of ACT in April 1999. We therefore include

the indicator variable ACT in equation (2) to control for structural shifts in the level of

repurchase activity over time. ACT takes the value of one for financial years ending

on or after April 1999 and zero otherwise.

In addition to examining the independent impact of underpricing, investment

opportunities, surplus cash and leverage on the share reacquisition decision, we follow

our analysis of repurchasing and nonrepurchasing firms by expanding equation (2) to

include the two-way interaction terms CASH×NRET, CASH×MTB and

CASH×HILEV. Consistent with our matched-pairs tests, we expect the CASH×MTB

and CASH×HILEV interaction terms to be negatively associated with ln(COST)

while the CASH×NRETt and CASH×NRETt-1 terms are expected to be positively

associated with ln(COST).

4. SAMPLE, DATA AND DESCRIPTIVE STATISTICS

Sample selection

U.K. firms are required to disclose details of all shares repurchased during the

fiscal year in their published financial statements. We use these disclosures to identify

14

open market share reacquisitions made by U.K.-domiciled firms listed on the London

Stock Exchange (exclusive of closed-end investment trusts). In the absence of reliable

machine-readable data on the volume and value of share buybacks, two

complimentary procedures are used to isolate potential repurchasers. First, we identify

firms with at least one share repurchase-related news event between 1 January 1995

and 31 December 2000. Repurchase news events are obtained from a variety of

sources including the Securities Data Corporation Mergers and Corporate

Transactions database (via Thompson Financial), the London Stock Exchange

Regulatory News Service (via Sequencer) and The Financial Times. Our sample

period begins in January 1995 since this was the earliest date that news

announcements were available on the Sequencer database. After screening the initial

set of events to remove non-U.K.-domiciled firms, non-listed firms and closed-end

investment trusts, we are left with a sample of 3,476 announcements relating to 456

firms.10 Secondly, we isolate all U.K.-domiciled firms in the Datastream alive and

dead stocks files that report at least one negative value for item #1101 (Net Capital

Issues) during our sample period but which are not included in our event sample. This

procedure results in an additional 32 firms. Combining these with our set of event

firms yields in a final sample of 488 potential repurchasing firms.

We examine all financial statements (via Global Access) with year-ends

between 1 January 1995 and 31 December 2000 for each firm in the potential

repurchasers sample to identify actual share reacquisitions. For all firm-years where

an open market repurchase is identified, we record the aggregate number, percentage

and cost of shares reacquired. Our final sample consists of 429 firm-year repurchases

made by 251 firms: 126 firms make reacquisitions in a single fiscal year during the

15

sample window, 85 firms make reacquisitions in two years and 40 firms make

reacquisitions in three or more years.

To identify our control sample of nonrepurchasing firms, we employ a

matched-pairs design whereby each of the 429 repurchasing firm-years are twinned

with a time-, industry- and size-matched nonrepurchasing firm using the following

procedure:

(a) Measure total assets employed (Datastream item #391) of the repurchasing

firm at the beginning of the fiscal year in which shares are repurchased;

(b) Identify all firms on the alive and dead stocks files in the same Datastream

level-6 industry group as the repurchasing firm with non-missing total assets

employed data for the same calendar year and which are not included in our

original sample of potential repurchasers;

(c) Select the firm that minimises the absolute difference in total assets employed,

subject to this difference not exceeding ±25% of the corresponding figure for

the repurchasing firm. In the event that this condition is not met, repeat steps

(b) and (c) using the Datastream level-4 industry classification. In the event

that the size condition is also exceeded at level-4, select the firm (level-4 or

level-6 industry group) that minimises the absolute difference in total assets

employed;

(d) Search the published financial statements of the selected firm to ensure that no

shares were repurchased during the five-year period centred on the matching

year. In the event that this condition is not met, repeat steps (b) and (c) using

the next best match available.

In 27 cases (6%), an appropriate match cannot be identified. This reduces the useable

matched sample to 402 matched-pairs.11 Of these cases, 314 (88) are matched with a

16

control firm at industry level-6 (level-4). The ±25% size criterion is met in 328 cases

(82%).

In addition to comparing repurchasers with their nonrepurchasing

counterparts, our analysis also involves modelling the cost of share repurchases for

firms that bought back shares in at least one year during our sample period.

Accordingly, we construct an unbalanced panel based on the 251 repurchasing firms,

consisting of all available fiscal years during the sample window (regardless of

whether or not a repurchase occurred in a given year). For firm-years where no shares

are acquired the value (fraction) of shares repurchased is equal to zero, otherwise it is

equal to the aggregate cost (fraction) of shares bought.

Financial statement and market data required to compute our test variables are

collected from Datastream. Unless otherwise indicated, all explanatory variables are

measured at the year-end immediately prior to the repurchase (nonrepurchase) year.

Missing financial statement data reduce our initial sample of 402 matched-pairs to

365 useable pairwise observations. The unbalanced panel based on our buyback

sample consists of 1,243 firm-year observations with data for all explanatory

variables, of which 393 firm-years (32%) are characterised by a repurchase.

Descriptive statistics

Table 1 reports descriptive statistics for our initial sample of 429 firm-year

open market share repurchases: panel A reports repurchases by value while panel B

reports the number of shares repurchased as a fraction of beginning-of-period shares

outstanding. The aggregate value of shares repurchased during our sample window is

almost £22 billion, with the average (median) deal worth £50.9 million (£2.7 million).

The 12-month aggregate amount of shares bought in the average open market

17

buyback is almost 5% of beginning-of-period shares outstanding. A striking feature of

the results reported in table 1 is the dramatic growth in buyback activity during the

sample period. For example, the number of firms repurchasing their shares in the open

market increased almost fivefold from 26 in 1995 to 120 in 2000. In addition to an

increase in the frequency of buybacks, both the value and fraction of shares

repurchased in the average deal also increased substantially: in 2000 the mean

(median) buyback cost £65.3 million (£4 million) compared with only £40.3 million

(£1.3 million) in 1995. Oswald and Young (2002b) attribute part of this increase in

buyback activity to changes in taxation, most notably the abolition of dividend tax

credits in July 1997 and the abolition of ACT in April 1999.

Table 2 presents descriptive statistics for the variables used in our subsequent

tests. Results are reported separately for the full sample of repurchasing firms with

data available from Datastream and for the repurchaser and nonrepurchaser matched

samples. Variables are measured at the beginning of the repurchase year unless

otherwise indicated. Relative to the matched control sample, repurchasing firms are

characterised by larger cash holdings, more distributable reserves and lower leverage.

In addition, the median dividend payout ratio and the mean EPS growth are

significantly higher for the repurchaser sample. Finally, despite our matching

procedure, the median repurchasing firm is significantly larger than its

nonrepurchasing counterpart.

The distribution of reacquiring firms by industrial sector is reported in table 3.

Our sample is characterised by significant industry clustering, with 34% of

repurchasing firms located in just three industries (Construction and Building,

Engineering and Real Estate). Further analysis reveals that this clustering does not

simply reflect characteristics of the Datastream population. Firms from the

18

Construction and Building, Electricity, Engineering and Real Estate sectors are

overrepresented in our sample relative to the Datastream population. In contrast, firms

from the Investments and Software sectors are underrepresented in our sample. These

findings suggest that industry-related factors may play an important role in explaining

share repurchase decisions.

Repurchase reasons disclosed by management

To gain preliminary insight into the drivers of open market share repurchases

we analyse the reasons cited by management for the buyback. Management’s stated

repurchase motives are collected from published annual reports and financial

statements, together with news announcements made to the London Stock Exchange

and reported in the financial press. Our findings are reported in table 4. Despite the

Listing Rules of the London Stock Exchange requiring companies to disclose the

reason(s) for a share repurchase, a large fraction of our sample (26%) failed to cite

any clear motive (beyond a bland statement indicating that the repurchase was

earnings enhancing). Of the remaining cases, several of the motives developed and

tested by extant research figure prominently. For example, paying-out surplus cash is

cited in 11% of cases, with the desire to distribute disposal proceeds cited in a further

5% of cases. Similarly, the desire to increase balance sheet efficiency is cited by

management as a reason for the repurchase in 14% of cases. We interpret such

statements as either further evidence consistent with the surplus cash hypothesis or as

evidence of firms attempting to achieve a target leverage ratio. More disturbing from

a theoretical perspective is the 5% of cases where a reduction in the cost of capital is

cited as a motive for the repurchase.12 Finally, management also cite underpricing

amongst their list of repurchase reasons.

19

Contrary to extant research however, the most frequently cited motive for an

open market share repurchase (29% of cases) is the desire to increase current and

future earnings per share (EPS). Precisely what firms mean here is unclear. One

interpretation is that managers fixate on earnings and believe that reported

performance can be boosted simply by reducing the magnitude of the denominator in

the EPS calculation. Of course, to the extent that reducing the capital base results in

lower earnings capability, such logic appears flawed. A more charitable interpretation

is that the stated aim of increasing current and future EPS represents managerial

shorthand for improving operating efficiency by paying-out excess funds whilst

maintaining the same level of earnings. As such, these statements are consistent with

both the signalling and surplus cash hypotheses.

In summary, management cite a variety of motives for open market share

repurchases, some of which accord with extant finance theory and some of which do

not. In addition, several reasons such as increasing EPS and creating a more efficient

balance sheet are difficult to decode because a number of alternative interpretations

are possible. We attempt to shed further light on the determinants of share buybacks

in the following section by examining the characteristics of repurchasing firms.

5. RESULTS

Distinguishing repurchasers from nonrepurchasers

Coefficient estimates and model summary statistics from conditional logistic

regressions relating the probability of a share reacquisition to measures of

underpricing, investment opportunities, surplus cash, leverage and a vector of control

variables are reported in table 5. In model 1, NRET is positive and significant at the

0.001 level as predicted, indicating that repurchasing firms are more likely to

20

underperform their nonrepurchasing counterparts over the 12-month period prior to

the repurchase year. In contrast, repurchasing firms are statistically indistinguishable

from their nonrepurchasing counterparts in terms of the market-to-book ratio (MTB).

The estimated coefficient on CASH is positive and significant at the 0.02 level. This

supports the prediction that repurchases are more likely to be used by firms with high

cash holdings. In addition, repurchasing firms are characterised by significantly lower

leverage, as indicated by the negative and significant coefficient estimate on the

HILEV term. This is consistent with Dittmar’s (2000) conjecture that firms use share

repurchases to manage their capital structure when the leverage ratio falls below its

target level. However, it is also consistent with the increased risk of financial distress

preventing highly geared firms from reacquiring their shares.

Analysis of the implied probabilities from model 1 suggests that NRET,

CASH and HILEV also have an economically significant impact on the likelihood of

a share repurchase. Holding all other factors constant, the implied probability of a

firm with negative market-adjusted returns making a share repurchase is almost 23%

higher than a firm with positive market-adjusted returns. Similarly, the repurchase

likelihood for undergeared firms is 36% higher than for firms whose gearing is above

the sample median, while an interquartile range increase in cash holdings raises the

implied probability of a repurchase by 13%.

The findings reported for model 1 are robust to inclusion of the vector of

control variables included (model 2). The estimated coefficient on the earnings per

share growth term (∆EPS) is positive and marginally significant (p = 0.12). This

provides weak evidence that firms with high EPS growth in prior-periods are more

likely to repurchase their shares. Of the remaining four control variables, the

estimated coefficients on SIZE and DIST are positive and significant at the 0.05 level,

21

suggesting that relative to nonrepurchasers, repurchasing firms are larger and have

more distributable profits, respectively. In contrast, the coefficient estimates on the

LOSS and PAYOUT terms do not attain significance at conventional levels.

Models 3–6 examine two-way interactions between several of our key test

variables. Model 3 includes the interaction between CASH and NRET. Similar to

models 1 and 2, the CASH main effect term continues to be positive and significant,

indicating that the probability of a repurchase increases in the level of cash holdings

for firms with above-market performance. However, the magnitude of the coefficient

estimate on CASH is more than double the corresponding values reported in models 1

and 2, indicating that the surplus cash effect is particularly strong in the absence of

poor prior-period performance: an increase in cash holdings from the first to the third

quartile increases the implied probability of a repurchase by 32% for firms

characterised by above-market performance. In addition, the NRET main effect also

becomes more pronounced in model 3 following inclusion of the interaction term.

Contrary to predictions, however, the CASH×NRET coefficient estimate is negative

and significant, indicating that the excess cash effect is significantly lower for

underperforming firms. Indeed, the coefficient on CASH is indistinguishable from

zero for underpriced firms (estimated coefficient = 0.599 [4.315 – 3.716]; p-value =

0.902). These findings suggest that the decision to distribute surplus cash via a share

repurchase is contingent on the absence of prior-period underperformance. In the

presence of perceived underpricing, firms with high cash holdings actually appear less

likely to repurchase their shares (estimated coefficient = –2.847 [0.869 – 3.716]; p-

value = 0.114).

In model 4 we examine interaction between CASH and MTB. The estimated

coefficient on the CASH×MTB term is indistinguishable from zero. Further, neither

22

the CASH nor MTB main effect coefficient estimates differ in any meaningful sense

from those reported in models 1 and 2. To the extent that the market-to-book ratio

captures aspects of the investment opportunity set, these results do not support the

view that firms with few investment opportunities are more likely to distribute cash

via a share repurchase. One possible explanation for this null result is that our

matched-pairs design lacks power. Specifically, our matched-pairs approach may have

controlled-out important inter-industry differences in investment opportunities. We

return to this issue in subsequent sections.

Model 5 examines the interaction between cash holdings and leverage. From a

surplus cash perspective, share repurchases are less likely to be used to disgorge cash

if the resulting buyback causes the gearing ratio to become excessively high, thereby

increasing the likelihood of debt covenant violation. This leads to the prediction that

the positive association between cash and the likelihood of a repurchase will be more

pronounced for firms with low leverage. The results reported for model 5 are

consistent with this prediction. The CASH×HILEV interaction term is negative and

significant at the 0.1 level. For firms with net leverage below the sample median, the

probability of a repurchase is increasing in the level of surplus cash (coefficient

estimate = 2.519; p-value = 0.01). In contrast, there is no link between cash holdings

and repurchase likelihood for firms whose net debt is above the sample median

(coefficient estimate = 0.542 [2.519 – 3.061]; p-value = 0.863).

While the coefficient estimate for the CASH main effect term continues to be

positive and significant, HILEV is rendered insignificant in model 5 following

inclusion of the cash-leverage interaction term. Rather, the significant negative

association between HILEV and the likelihood of a share repurchase is confined to

firms with high cash holdings (estimated coefficient = –3.244 [–3.061 – 0.183]; p-

23

value = 0.077). These findings are inconsistent with the optimal leverage hypothesis,

which predicts that firms initiate share repurchases whenever gearing falls below

target regardless of the level of cash holdings. Instead, our results suggest that gearing

affects the repurchase decision only indirectly via its intervening effect on the

association between repurchase likelihood and surplus cash.

Model 6 in table 5 is the full model, comprising all main effect and two-way

interaction terms. The results are qualitatively identical to those reported in models 3–

5. Specifically, of our test variables, NRET and CASH emerge as the dominant

factors affecting the likelihood of a share repurchase. In addition, CASH appears to

interact with both prior-period share price performance and gearing in determining the

repurchase decision. While the negative estimated coefficient on the CASH×HILEV

interaction term accords with our predictions, the negative interaction between CASH

and NRET is contrary to the view that firms wishing to distribute excess cash are

more likely to do so in the presence of perceived underpricing.

Explaining the amount spent on repurchases

In this section we provide further evidence on the drivers of share

reacquisitions by estimating equation (2) on an unbalanced panel comprising all firm-

year observations between January 1995 and December 2000 for firms making at least

one open market share repurchase during this period. Coefficient estimates and

summary statistics for several versions of equation (2) are reported in table 6. In

model 1, the estimated coefficients on NRETt and NRETt-1 are positive as predicted

but only the lagged measure is significant at conventional levels. The coefficient

estimate on CASH is also positive and significant in model 1. These results, which are

consistent with those reported for the matched-pairs analysis in table 5, suggest that

24

prior-period market performance and cash holdings are important factors explaining

the amount spent on share repurchases. In addition, the market-to-book ratio is also

negative and significant in model 1. This provides further support for the underpricing

hypothesis. It is also consistent with the prediction that firms repurchase their shares

when alternative investment opportunities are scarce. In contrast, our results provide

no support for the prediction that share repurchases are a response to high information

asymmetry per se. Although the estimated coefficient on HILEV is negative as

predicted by the optimal leverage hypothesis, it is not significant at conventional

levels. These findings provide further support for the conclusion that share

repurchases and leverage are not directly related.

The positive coefficient on NRETt becomes significant at the 0.05 level in

model 2 following inclusion of the vector of control variables, indicating that in

addition to lagged underperformance, firms spend more on share repurchases when

contemporaneous performance is poor. Coefficient estimates on the remaining test

variables in model 2 remain broadly similar to those in model 1. Of the control

variables, LOSS and ACT are significant at the 0.05 level or better. The negative

coefficient on LOSS supports the prediction that the absence of surplus ACT in the

pre-April 1999 period acted as an important constraint on repurchase activity.

Consistent with this view, the amount spent on open market repurchases increased

dramatically following the abolition of ACT, as evidenced by the large positive

coefficient on the ACT indicator variable. The estimated coefficient on ∆EPS is

indistinguishable from zero, providing no support for the prediction that firms with

high prior-period EPS growth use share repurchases in an attempt to maintain such

growth in future periods.

25

In model 3 we extend equation (2) to include the two-way interactions

between cash holdings and our underpricing, market-to-book ratio and leverage

proxies. Coefficient estimates on the CASH and NRETt-1 main effect terms remain

robust to the inclusion of these interaction terms. In contrast, NRETt and MTB are no

longer significant at conventional levels. In addition, none of the two-way interaction

terms are significant. These results do not support the view that the level of cash

holdings interacts with either market-adjusted returns, the market-to-book ratio or

leverage in determining share repurchase activity. The insignificant coefficient

estimates on CASH×HILEV and CASH×NRETt-1 contrast with the matched-pairs

results reported in table 5.

Models 4 and 5 in table 6 repeat the previous analysis after trimming the

sample to remove the extreme top and bottom percentiles of each test variable. Whilst

the findings for model 4 are virtually identical to those reported for model 2 using the

full sample, the two-way interactions reported in model 5 are sensitive to the

exclusion of extreme values. Specifically, both the CASH×NRETt and CASH×MTB

interaction terms are significant at the 0.1 level following trimming. The positive

coefficient estimate on CASH×NRETt indicates that firms with high cash balances

make larger distributions to shareholders when contemporaneous market performance

is poor: the estimated coefficient on CASH is 28.317 (14.321 + 13.996; p-value =

0.042) when year t returns undershoot the market, compared with only 14.321 when

year t returns exceed the market. This supports the view that firms time distributions

of excess cash to take advantage of perceived undervaluation, thereby creating

additional value for shareholders. The negative coefficient on the CASH×MTB

interaction term also supports the timing hypothesis. However, it is also consistent

with the prediction that firms with high cash holdings and low investment

26

opportunities are more likely to use repurchases to distribute surplus cash to

shareholders: the estimated coefficient on CASH is 14.321 (p-value = 0.09) for low

market-to-book firms, compared with only 10.762 (14.321 – 3.559; p-value = 0.391)

for high market-to-book firms.

Investment opportunities: industry-level analysis

Theory suggests that share repurchases are a response to high cash holdings in

the presence of limited investment opportunities. Firms’ investment opportunities are

to a large extent determined by the industry in which they operate (Smith and Watts,

1992). Results presented in table 3 indicate significant industry clustering with respect

to share repurchase activity. However, tests reported in the previous sections focus

solely on explaining intra-industry variation in repurchase activity and as such provide

weak tests of the investment opportunity set hypothesis.

To shed further light on the link between share repurchases and investment

opportunities, we adopt an alternative testing procedure that better captures inter-

industry variation in buyback activity. Specifically, we estimate an industry-level

version of equation (2) where the dependent variable is the average amount spent on

share repurchases by all firms in industry k during calendar year t and all explanatory

variables are defined as their corresponding industry-year averages (measured at time

t-1). The model is estimated using all Datastream level-4 industry groups listed in

table 3 with available data and industry-year averages are computed using all

available firms on the Datastream alive and dead stocks files. The final dataset

consists of 225 industry-year observations for calendar years 1995 to 2000 (inclusive).

Summarised results are as follows (two-tailed p-values in parentheses):13

27

(0.04) (0.01) (0.84) (0.18) CASHMTB eCASH eMTB eeCOST tktktktktk 1,1,

61,

61,

66, 37.2085.2705..185.3 −−

−−

−−

−− ×−+−−=

Adjusted-R2 = 7.99%; F–statistic = 2.94

Average cash holdings are positively related to the amount spent on share repurchases

in industry k. While the estimated coefficient on the industry market-to-book ratio

main effect term is not significant, the interaction between MTB and CASH is

negative and significant, indicating that the positive association between buybacks

and cash holdings is lower in industries comprising high market-to-book firms.

Indeed, for high MTB industries, the association between repurchases and CASH is

indistinguishable from zero (coefficient estimate = 7.48e-6 [27.85e-6 – 20.37e-6]; p-

value = 0.65). Assuming that the market-to-book ratio captures elements of the

investment opportunity set, these findings lend further support to the prediction that

share repurchases are used more frequently when cash holdings are high and

investment opportunities are limited.

6. SUMMARY AND CONCLUSIONS

Once the sole domain of U.S. corporations, share repurchases are becoming an

increasingly common phenomenon among their U.K. counterparts. Between January

1995 and December 2000, we find that U.K. firms spent almost £22 billion on open

market share repurchases and recent reports in the financial press suggest that this

trend is set to continue. Further, the U.K. represents an interesting setting in which to

explore share repurchase activity because of the legal requirement for firms to report

the number and cost of share reacquisitions in their published financial statements.

This means that accurate measures of share repurchase activity are readily available in

the U.K. This contrasts with the situation in the U.S. where researchers are forced to

use proxies for the number and value of shares repurchased.

28

We begin by analysing the buyback reasons cited by management and find

that the desire to pay out surplus cash figures prominently. However, the reason most

frequently cited by U.K. managers (29% of cases) is the desire to increase earnings

per share. Precisely what is meant by such a statement is unclear: on the one hand it

may suggest that managers fixate on earnings per share growth and believe that

reported performance can be enhanced simply by reducing the magnitude of the

denominator in the EPS calculation; on the other it may be managerial shorthand for

improving operating efficiency by paying-out excess funds whilst maintaining the

same earnings capability. Other frequently cited motives such as increasing balance

sheet efficiency are equally difficult to decode. Given the ambiguity associated with

such statements, coupled with the fact that over half of our sample failed to disclose

any motive for the buyback, we examine the characteristics of repurchasing firms as

an indirect means of shedding further light on the determinants of share buybacks.

Comparing repurchasing firms with a time-, industry- and size-matched

sample of nonrepurchasers reveals high cash holdings and poor prior-period share

price performance to be the key factors driving the repurchase decision. Similar

results emerge when we model the amount spent on repurchasing shares. These

findings are consistent with the view that share repurchases are a response to the

problems of surplus cash and perceived market underpricing, respectively. Our

underpricing results do not support Rau and Vermaelen’s (2002) conjecture that

regulatory restrictions in the U.K. prevent firms from using repurchases to exploit

perceived instances of market mispricing.

Additional tests reveal that the positive association between cash holdings and

the amount spent on share repurchases is stronger for firms with low market-to-book

ratios. To the extent that the problem of surplus cash are likely to be most acute when

29

investment opportunities are limited (i.e., low market-to-book firms), these results

provide further evidence that firms use repurchases as a means of mitigating the

agency problems of excess cash.

In contrast to Dittmar (2000), we find no evidence of a direct association

between repurchases and leverage. As such, our results do not support the view that

U.K. firms use share repurchases to manage their capital structure when gearing

undershoots some predetermined optimal level. However, further tests suggest that

gearing may affect the repurchase decision indirectly via its intervening effect on the

association between repurchase likelihood and surplus cash. Specifically, we find that

the positive association between repurchases and surplus cash is more pronounced

when gearing is low. We interpret these findings as evidence that the increased risk of

financial distress constrains the ability of already highly geared firms to distribute

surplus cash via a share repurchase.

30

NOTES 1 However, Barth and Kasznik (1999) report a negative association between announcement-

period returns and surplus cash. Their results contrast with those reported by Lie (2000) and

suggests that rather than viewing repurchases as a cure for agency problems associated with

surplus cash, market participants view the distribution of surplus cash as bad news because it

indicates a lack of available positive net present value projects. 2 Stephens and Weisbach (1998) study a sample of 450 open market share repurchase

announcements made by US firms and find that approximately one quarter of all shares

targeted at the time of the announcement remain unacquired at the end of the three-year

postannouncement period. Similarly, Ikenberry et al. (2000) report that over 95% of Canadian

repurchase announcers fail to fully complete their buybacks programmes, with approximately

one quarter of announcers failing to make any repurchases. 3 We do not consider the use of open market share reacquisitions as a takeover defense

mechanism because as Allen and Michaely (2002) discuss, such effects are likely to be

restricted to self-tender offers in which a large fraction of shares are bought over a short

period. In addition, we do not examine the association between share reacquisitions and the

level of share options outstanding because in contrast to the U.S. where reacquired shares can

be held as treasury stock for reissue in later periods, U.K. company law requires all

repurchased shares to be cancelled. The absence of the treasury stock option in the U.K.

increases the cost of using buybacks as a means of countering the dilutive effects of options.

4 Because our share reacquisition data are obtained from firms’ published financial statements

measured on an annual basis, share returns measured over fiscal year t-1 may represent a poor

(i.e., untimely) underpricing proxy for firms that acquire shares towards the end year t. We

addressed this issue in untabulated tests by including contemporaneous returns in equation (1)

as an additional explanatory variable. In no case, however, did this variable attain significance

at conventional levels.

5 Our prediction is based on the view that managers are more likely to perceive an

underpricing problem in the wake of a recent deterioration in share price. Whether in reality

price declines signal underpricing remains an unresolved issue (Brennan et al., 1998;

Jegadeesh and Titman, 1993; Chopra et al., 1992; DeBondt and Thaler, 1985). 6 Prior to the abolition of ACT in April 1999, open market share repurchases qualified as

distributions for tax purposes and as such generated an ACT charge. In the absence of surplus

ACT capacity against which to offset this charge, buybacks resulted in firms incurring an

additional tax liability. Accordingly, open market repurchases were relatively unattractive to

firms seeking to minimise their ACT liability (e.g., loss-making firms).

31

7 If reported earnings are negative but the firm still pays a dividend we set DIVPAY equal to

the ratio of dividends paid divided by six percent of total assets (Lee and Swaminathan,

1999). For nondividend firms paying firms with negative reported earnings we set DIVPAY

equal to zero.

8 As a specific example of the interaction between the surplus cash and underpricing

hypotheses, Oswald and Young (2002b) discuss how Barclays Plc appeared to exploit short-

term dips in its share price to create further value for non-selling shareholders during its £2.6

billion buyback programme aimed at disgorging excess cash.

9 To avoid generating missing values, we redefine COST as being equal to 10-9 in years where

no shares are acquired. In alternative specifications (not tabulated) we re-estimated equation

(2) after replacing ln(COST) with the percentage of shares repurchased. We estimated a

logistic version of equation (2) in which the dependent variable takes the value of one for a

repurchase year and zero otherwise. In both cases, the tenor of our results does not change.

10 We retain all firms with at least one news announcement, regardless of the specific nature

of the announcement. Announcements cover a wide spectrum of events including: proposals

to seek authority to repurchase shares at a forthcoming Annual or Extraordinary General

Meeting; confirmation that repurchase authority has been granted at a recent General

Meeting; plans to implement a specific buyback programme; plans to resume, continue with

or extend an existing repurchase plan; and notification of actual share reacquisitions.

11 The 27 nonmatching cases occur due to an absence of nonrepurchasing firms in the same

industry group (i.e., all firms in the industry either announced repurchase intentions or

implemented a buyback during the five-year period centred on the announcement year). The

nonmatching cases are drawn almost exclusively from the utilities sector. As a result, findings

based on the comparison of repurchasing and nonrepurchasing firms may not be

generaliseable to firms in the electricity and water industries.

12 Closer inspection of the relevant disclosures suggests that this is not a tax shield story.

Rather, managers appear to believe that a reduction in the cost of capital can be achieved by

replacing ‘expensive’ equity with ‘cheap’ debt. 13 The full model from which these summarized results are drawn is:

,,,11

1,10

1,91,81,7

1,

1,1,5

1,4

1,1,2

,0

,

tktktktk

tktktk

tktktktk3

tktki

tk

ACTPAYOUTDISTLOSSEPSHILEV

CASHMTBCASHMTB NRETNRETCOST

υωωωωωω

ωωωωωω

+++++∆++

×+++++=

−−−−

−

−−−−−

where ¯ indicates that variables are measured as the means for industries 1 to K at time t-1.

32

References

Allen, F. and R. Michaely (2002), ‘Payout Policy’, in G. Constantinides, M. Harris

and R. Stulz, eds. North-Holland Handbooks of Economics. Elsevier: Amsterdam.

Bagwell, L. (1991), ‘Share Repurchases and Takeover Deterrence’, RAND Journal of

Economics, Vol. 22, pp.72-88.

Barth, M. and R. Kasznik (1999), ‘Share Repurchases and Intangible Assets’, Journal

of Accounting and Economics, Vol. 28, pp.211-241.

Brennan, M., T. Chordia and A. Subrahmanyam (1998), ‘Alternative Factor

Specifications, Security Characteristics, and the Cross-Section of Expected Stock

Returns’, Journal of Financial Economics, Vol. 49, pp.345-378.

Breslow, N. (1982), ‘Covariance Adjustment of Relative-Risk Estimates in Matched

Studies’, Biometrics, Vol. 38, pp. 661-672.

Chopra, N, J. Lakonishok and J. Ritter (1992), ‘Measuring Abnormal Returns: Do

Stock Overreact?’, Journal of Financial Economics, Vol. 31, pp.235-268.

Comment, R. and G. Jarrell (1991), ‘The Relative Power of Dutch-Auction and Fixed-

Price Self-Tender Offers and Open Market Share Repurchases’, Journal of Finance,

Vol. 46, pp.1243-1271.

DeBondt, W. and R. Thaler (1985), ‘Does the Stock Market Overreact?’ Journal of

Finance, Vol. 40, pp.793-805.

Dittmar, A. (2000), ‘Why Do Firms Repurchase Stock?’ Journal of Business, Vol. 73,

pp.331-55.

Fenn, G. W. and N. Liang (2001), ‘Corporate Payout Policy and Managerial Stock

Incentives’, Journal of Financial Economics, Vol. 60, pp.45-72.

Grullon, G. and R. Michaely (2000), ‘The Information Content of Share Repurchase

Programs’, Working paper, University of Cornell.

33

Harford, J., (1999), ‘Corporate Cash Reserves and Acquisitions’, Journal of Finance

Vol. 64, pp.1969-1997.

Ikenberry, D., J. Lakonishok and T. Vermaelen (1995), ‘Market Underreaction to

Open Market Share Repurchases’, Journal of Financial Economics, Vol. 39,

pp.181-208.

Ikenberry, D., J. Lakonishok and T. Vermaelen (2000), ‘Share Repurchases in

Canada: Performance and Strategic Trading’, Journal of Finance, Vol. 54, pp.237-

2397.

Jagannathan, M., C. Stephens and M. Weisbach (2000), ‘Financial Flexibility and the

Choice Between Dividends and Stock Repurchases’, Journal of Financial

Economics, Vol. 57, pp.355-384.

Jegadeesh, N. and S. Titman (1993), ‘Returns to Buying Winners and Selling Losers:

Implications for Stock Market Efficiency’, Journal of Finance, Vol. 48, pp.65-91.

Jensen, M. 1986. Agency problems of free cash flow, corporate finance and takeovers.

American Economic Review 76: 323-329.

Kahle, K. (2002), ‘When a Share Buyback Isn’t a Buyback: Open Market

Repurchases and Employee Options’, Journal of Financial Economics, Vol. 63, pp.

235-261.

Lakonishok, J., A. Schleifer, R. and R. Vishny (1994), ‘Contrarian Investing,

Extrapolation and Risk’, Journal of Finance, Vol. 49, pp.1541-1578.

Lakonishok, J. and T. Vermaelen (1990), ‘Anomalous Price Behaviour Around

Repurchase Tender Offers’, Journal of Finance, Vol. 45, pp.455-477.

Lang, l. and R. Litzenberger (1989), ‘Dividend Announcements: Cash-flow Signalling

versus Free Cash Flow Hypothesis?’, Journal of Financial Economics, Vol. 24,

pp.181-191.

34

Lasfer, M. (2001), ‘The Market Valuation of Share Repurchases in Europe’, working

paper, City University.

Lee, C. and M. Swaminathan (1999), ‘Valuing the Dow: A Bottom-up Approach’,

Financial Analysts Journal, September/October, pp.4-23.

Lie, E. (2000), ‘Excess Funds and Agency Problems: An Empirical Study of

Incremental Cash Disbursements’, Review of Financial Studies, Vol. 13, pp.219-

248.

Newbold, P. (1988). Statistics for Business and Economics 2nd Ed. Prentice-Hall.

Oswald, D. and S. Young (2002a), ‘What Role Taxes and Regulation: A Second Look

at Open Market Share Repurchase Activity in the United Kingdom’, Working paper,

London Business School.

Oswald, D. and S. Young (2002b), ‘Boom Time for Buybacks’, Accountancy, Vol.

130 (October), pp.52-53.

Rau, P. and T. Vermaelen (2002), ‘Regulation, Taxes and Share Repurchases in the

U.K.’, Journal of Business Vol. 75, pp.245-82.

Rees, W. (1996), ‘The Impact of Open Market Equity Repurchases on U.K. Equity

Prices’, European Journal of Finance, Vol. 2, pp. 353-370.

Stephens, C. and M. Weisbach (1998), ‘Actual Share Reacquisitions in Open Market

Repurchase Programs’, Journal of Finance, Vol. 53, pp.313-333.

Smith, C. and R. Watts (1992). ‘The Investment Opportunity Set and Corporate

Financing, Dividends and Compensation Policies’, Journal of Financial Economics,

Vol. 32, pp.263-292.

Vermaelen, T. (1981), ‘Common Stock Repurchases and Market Signalling: An

Empirical Study’, Journal of Financial Economics, Vol. 9, pp.139-83.

35

Table 1 Descriptive statistics for open market share reacquisitions made by U.K.-domiciled firms between January 1 1995 and December 31 2000. The sample is drawn from all firms with at least one repurchase announcement reported by either Sequencer, The Financial Times or the Securities Data Corporation during the sample period, plus all remaining firms in the Datastream alive and dead stocks files with at least one negative value for item #1101 (Net Capital Issues) during the same period. The final sample consists of 429 firm-year observations. Repurchase data are collected directly from firms’ published financial reports.

Panel A: Value of shares repurchased (£ million)

Year N Mean St. dev Q3 Median Q1 Sum 1995 26 40.319 103.407 35.300 1.254 0.275 1048.300 1996 42 63.446 156.308 21.235 2.238 0.227 2664.730 1997 49 53.646 116.070 25.400 3.068 0.441 2628.650 1998 87 35.219 108.705 11.701 2.000 0.648 3064.090 1999 105 43.648 144.412 15.300 2.600 0.704 4583.080 2000 120 65.321 205.770 30.908 3.951 1.1695 7838.540

All 429 50.880 154.385 21.000 2.675 0.648 21827.386

Panel B: Fraction of outstanding shares repurchased a

Year N Mean St. dev Q3 Median Q1 1995 26 0.045 0.041 0.079 0.032 0.011 1996 42 0.052 0.042 0.079 0.048 0.017 1997 49 0.046 0.058 0.055 0.028 0.010 1998 87 0.038 0.036 0.050 0.025 0.013 1999 105 0.047 0.053 0.060 0.029 0.014 2000 120 0.057 0.062 0.077 0.040 0.014

All 429 0.048 0.052 0.064 0.031 0.013

a Number of ordinary shares repurchased in the open market during the fiscal year as a fraction of total shares outstanding at the beginning of the year.

36

Tab

le 2

D

escr

iptiv

e st

atis

tics f

or v

aria

bles

use

d to

exp

lain

the

shar

e re

acqu

isiti

on d

ecis

ion.

The

repu

rcha

ser s

ampl

e co

nsis

ts o

f UK

-dom

icile

d fir

ms l

iste

d on

the

Lond

on S

tock

Exc

hang

e th

at m

ade

shar

e re

acqu

isiti

ons b

etw

een

Janu

ary

1 19

95 a

nd D

ecem

ber 3

1 20

00. S

hare

reac

quis

ition

s are

iden

tifie

d us

ing

anno

unce

men

ts re

porte

d by

The

Sec

uriti

es D

ata

Cor

pora

tion,

Seq

uenc

er a

nd T

he F

inan

cial

Tim

es, t

oget

her w

ith n

egat

ive

valu

es o

f Dat

astre

am it

em #

1101

(N

et C

apita

l Iss

ues)

. Whe

re p

ossi

ble,

repu

rcha

sers

are

mat

ched

with

a si

mila

r non

repu

rcha

sing

firm

on

the

basi

s of c

alen

dar y

ear,

indu

stry

and

size

.

M

atch

ed sa

mpl

e

Ope

n m

arke

t rep

urch

aser

s R

epur

chas

ers

Non

repu

rcha

sers

p-

valu

esb

Var

iabl

ea N

M

ean

St. d

evM

edia

n N

Mea

n St

. dev

M

edia

nN

M

ean

St. d

ev

Med

ian

t-tes

t W

ilcox

on

Exce

ss re

turn

t 41

1

-0.0

280.

488

-0.0

7936

1-0

.028

0.50

5 -0

.081

315

0.00

50.

628

-0.0

460.

051

0.01

2Ex

cess

retu

rn t-1

41

5

-0.0

980.

321

-0.1

3436

5-0

.111

0.32

0-0

.149

365

-0.0

810.

427

-0.1

090.

233

0.24

1M

arke

t-to-

book

ratio

t-1

413

1.68

21.

681

1.21

836

51.

709

1.76

11.

207

365

2.07

310

.105

1.22

90.

499

0.84

7C

ash

t-1

416

0.12

40.

142

0.07

436

50.

121

0.13

70.

072

365

0.09

10.

106

0.05

70.

001

0.00

2N

et le

vera

ge t-

1 41

60.

340

0.51

00.

398

365

0.35

40.

502

0.40

536

50.

453

0.33

60.

465

0.00

10.

001

EPS

grow

th t-

1 40

20.

350

3.95

60.

076

365

0.32

84.

136

0.06

636

5-0

.611

7.43

80.

107

0.03

50.

105

Rese

rves

t-1

416

0.30

30.

225

0.30

136

50.

300

0.22

20.

304

365

0.17

40.

364

0.19

90.

001

0.00

1Si

ze t-

1 (£

mill

ions

) 41

6 61

44.8

40

28

779.

000

16

0.18

7

365

5953

.200

289

41.5

00

15

5.50

9

365

5438

.320

2576

0.40

0

152.

803

0.

323

0.00

6 D

ivid

end

payo

ut ra

tio t-

1 41

60.

573

0.87

10.

428

365

0.57

40.

796

0.43

436

50.

876

4.47

40.

381

0.20

70.

003

a Var

iabl

e de

finiti

ons a

re a

s fol

low

s (D

atas

tream

item

s in

pare

nthe

ses)

: Exc

ess r

etur

n is

the

12-m

onth

mar

ket-a

djus

ted

shar

e re

turn

mea

sure

d ov

er fi

scal

yea

r t,

the

Mar

ket-t

o-bo

ok ra

tio is

de

fined

as t

he m

arke

t val

ue o

f equ

ity (H

MV

) plu

s the

boo

k va

lues

of p

refe

renc

e di

vide

nds (

306)

and

long

-term

deb

t (32

1) d

ivid

ed b

y ne

t tot

al a

sset

s (39

1), C

ash

is th

e ra

tio o

f cas

h an

d ca

sh

equi

vale

nts (

375)

to to

tal a

sset

s (39

2), N

et le

vera

ge is

tota

l cur

rent

liab

ilitie

s (39

8) p

lus l

ong-

term

deb

t (32

1) m

inus

cas

h an

d ca

sh e

quiv

alen

ts (3

75) d

ivid

ed b

y to

tal a

sset

s min

us c

ash

and

cash

eq

uiva

lent

s, EP

S gr

owth

is th

e ch

ange

in e

arni

ngs p

er sh

are

(625

/ N

S) sc

aled

by

the

abso

lute

val

ue o

f beg

inni

ng-o

f-pe

riod

earn

ings

per

shar

e, R

eser

ves i

s tot

al sh

areh

olde

rs’ r

eser

ves (

304)

sc

aled

by

tota

l ass

ets (

392)

, Siz

e is

tota

l ass

ets (

392)

, and

the

Div

iden

d pa

yout

ratio

is o

rdin

ary

divi

dend

s (18

7) d

ivid

ed b

y ea

rnin

gs fo

r ord

inar

y sh

areh

olde

rs (6

25).

For d

ivid

end

payi

ng fi

rms

with

neg

ativ

e ea

rnin

gs, t

he D

ivid

end

payo

ut ra

tio is

def

ined

as d

ivid

ends

pai

d di

vide

nd b

y si

x pe

rcen

t of t

otal

ass

ets.

For n

ondi

vide

nd p

ayin

g fir

ms w

ith n

egat

ive

earn

ings

, the

Div

iden

d pa

yout

ra

tio is

set e

qual

to z

ero.

Yea

r t is

the

fisca

l yea

r in

whi

ch a

shar

e re

purc

hase

occ

urre

d. Y

ear t

-1 is

the

fisca

l yea

r pre

cedi

ng th

e re

purc

hase

yea

r. b T

wo-

taile

d p-

valu

es fo

r mat

ched

-pai

rs te

sts o

f the

diff

eren

ce b

etw

een

repu

rcha

sing

and

non

repu

rcha

sing

firm

s.

37

Table 3 Industrial classification of U.K.-domiciled firms making open market share reacquisitions between January 1 1995 and December 31 2000. The sample is drawn from all firms with at least one repurchase announcement reported by either Sequencer, The Financial Times or the Securities Data Corporation during the sample period, plus all remaining firms in the Datastream alive and dead stocks files with at least one negative value for item #1101 (Net Capital Issues) during the same period. The final sample of 429 firm-year observations consists of 251 individual firms. Industry groups are based on the Datastream level-4 classification.

Universea Repurchasersb Universea Repurchasersb Industry group % N % Industry group % N % Aerospace 0.60 2 0.80 IT support 0.02 0 0.00 Automobiles & parts 0.94 2 0.80 Leisure & entertain. 6.14 13 5.18 Banks 1.11 6 2.39 Life assurance 0.43 1 0.40 Beverages 0.77 2 0.80 Media & photography 6.16 8 3.19 Chemicals 2.10 3 1.20 Mining 2.22 3 1.20 Construction & building 5.34 23 9.16* Off shore investment 0.36 0 0.00 Distributors 3.26 12 4.78 Oil & gas 2.46 4 2.39 Diversified industrials 0.89 0 0.00 Other business 4.18 2 0.80* Electricity (utilities) 1.28 13 5.18** Packaging 1.38 1 0.40 Electronics 5.10 9 3.59 Personal care 0.36 0 0.00 Engineering 5.48 25 9.96* Pharmaceuticals 1.64 2 0.80 Food & drug retailers 0.92 2 0.80 Real estate 5.92 38 15.14* Food producers 3.02 12 4.78 Retailers (general) 4.44 14 5.58 Forestry & paper 0.19 0 0.00 Software 4.78 3 1.20* Gas distribution 0.14 0 0.00 Speciality finance 4.42 8 3.19 Household goods 4.57 13 5.18 Steel 0.70 1 0.40 Healthcare 1.62 1 0.40 Support services 5.43 8 3.19 IT hardware 1.14 2 0.80 Telecommunications 1.09 0 0.00 Insurance support 0.17 0 0.00 Tobacco 0.19 1 0.40 Insurance 1.50 2 0.80 Transport 2.15 9 3.59 Investments 2.92 0 0.00* Water (utilities) 1.64 6 2.39

Total 251

a All Datastream firms in a given level-4 industry group as a percentage of the total population of Datastream firms (N = 4140). b All repurchasing firms in a given Datastream level-4 industry group as a percentage of all repurchasing firms (N = 266). * (**) Sample proportion differs from the universe proportion at the p < 0.05 (0.01) level based on a proportional Z-test (Newbold, 1988).

38

Table 4 Repurchase reasons disclosed by management. The sample consists of U.K.-domiciled firms making open market share reacquisitions between January 1 1995 and December 31 2000. Repurchase reasons are collected from firms’ published annual reports, together with announcements made to the London Stock Exchange and the financial press.

Reason disclosed in:

Annual report a Annual report or initial

announcement b Disclosed reason for buyback N % of firms c N % of firms c No reason 148 28.96 140 25.83 Increase earnings per share 148 28.96 155 28.60 Firm is undervalued 23 4.50 27 4.98 Increase balance sheet efficiency 73 14.29 77 14.21 Distribute excess cash 55 10.76 61 11.26 Defend against takeover 0 0.00 1 0.18 Distribute disposal proceeds 17 3.33 25 4.61 Reduce the cost of capital 23 4.50 25 4.61 Return of value 7 1.37 11 2.03 Other 17 3.33 20 3.69

Total 511 542

a Firms disclosing a given reason in their annual report. b Firms disclosing a given reason in either their annual report or in their initial buyback announcement. c Frequency of a given reason divided by total number of repurchasing firm-years (N = 429). Aggregate percentages exceed 100% because some firms disclose multiple reasons.

39

Table 5 Conditional logistic regressions relating the probability of an open market share reacquisition over the period January 1995 and December 2000 to measures of undervaluation, investment opportunities, cash holdings, gearing and a vector of control variables. Repurchasing firms are matched with a similar nonrepurchasing firm on the basis of calendar year, industry and size. The dependent variable in the conditional logistic models takes the value of one for each of the 365 matched pairs in our sample while all explanatory variables are defined as the pairwise difference between the ith repurchaser and its corresponding matched nonrepurchaser. Probability values (two-tailed) are reported in parentheses.

Model:a

1,91,81,71,6

1,51,41,31,21,1)Pr(

−−−−

−−−−−

++++

∆++++=

titititi

tititititii

DISTSIZEDIVPAYLOSS

EPSHILEVCASHMTBNRETurchaseRep

γγγγ

γγγγγ

Variable Model 1 Model 2 Model 3 Model 4 Model 5 Model 6 NRETt-1 0.505 0.493 0.869 0.487 0.475 0.835 (0.004) (0.006) (0.000) (0.006) (0.008) (0.001) MTB -0.005 -0.003 -0.004 -0.010 -0.004 -0.011 (0.713) (0.791) (0.782) (0.653) (0.735) (0.622) CASH 1.879 1.754 4.315 1.508 2.519 4.797 (0.019) (0.029) (0.002) (0.085) (0.008) (0.003) HILEV -0.555 -0.458 -0.481 -0.456 -0.183 -0.210 (0.002) (0.012) (0.009) (0.012) (0.445) (0.386) CASH × NRETt-1 − − -3.716 − − -3.706 (0.022) (0.028) CASH × MTB − − − 0.100 − 0.095 (0.478) (0.490) CASH × HILEV − − − − -3.061 -2.965 (0.083) (0.098) ∆EPS − 0.026 0.026 0.026 0.027 0.027 (0.120) (0.131) (0.119) (0.108) (0.116) LOSS − -0.313 -0.371 -0.307 -0.334 -0.387 (0.313) (0.231) (0.323) (0.284) (0.214) PAYOUT − -0.052 -0.054 -0.052 -0.051 -0.053 (0.218) (0.213) (0.217) (0.215) (0.210) SIZE − 0.595 0.632 0.592 0.586 0.619 (0.031) (0.024) (0.031) (0.032) (0.025) DIST − 0.775 0.746 0.781 0.764 0.743 (0.018) (0.022) (0.017) (0.020) (0.024)

N 365 365 365 365 365 365 χ2 p-value b 0.001 0.001 0.001 0.001 0.001 0.001

Implied probability of repurchase announcement for top and bottom quartiles c Base case 0.522 0.534 0.533 0.535 0.549 0.549 NRET Top quartile 0.644 0.652 0.731 0.652 0.662 0.737 Bottom quartile 0.522 0.534 0.533 0.535 0.549 0.549 MTB Top quartile 0.520 0.533 0.532 0.533 0.548 0.546 Bottom quartile 0.522 0.534 0.533 0.536 0.549 0.549

40

Table 5 (continued) CASH Top quartile 0.550 0.560 0.598 0.558 0.587 0.620 Bottom quartile 0.486 0.501 0.452 0.507 0.502 0.459 HILEV Top quartile 0.385 0.420 0.414 0.422 0.503 0.496 Bottom quartile 0.522 0.534 0.533 0.535 0.549 0.549 CASH × NRET Top quartile − − 0.496 − − 0.512 Bottom quartile − − 0.582 − − 0.597 CASH × MTB Top quartile − − − 0.536 − 0.549 Bottom quartile − − − 0.531 − 0.545 CASH × HILEV Top quartile − − − − 0.526 0.526 Bottom quartile − − − − 0.563 0.562

a The dependent variable is an indicator variable taking the value of one for each repurchaser–nonrepurchaser matched pair. Explanatory variables are defined as the difference between each repurchaser–nonrepurchaser matched pair. Variable definitions prior to differencing are as follows: NRET is an indicator variable taking the value of one if the 12-month excess return is positive and zero otherwise, MTB is the unlevered market-to-book ratio market value of equity, CASH is the ratio of cash and cash equivalents to total assets, HILEV is an indicator variables taking the value of one if net leverage is above the sample median and zero otherwise, ∆EPS is earnings per share growth, LOSS is an indicator variable taking the value of one if reported earnings are negative and zero otherwise, PAYOUT is the dividend payout ratio, SIZE is the natural logarithm of total assets and DIST is an indicator variable taking the value of one if reserves are positive and zero otherwise. Further details of all variables (including Datastream item codes) are reported in table 2. All variables are measured at the fiscal year-end preceding the repurchase year (t-1). b Probability value for the likelihood ratio test. c For all continuous variables, implied probabilities for top and bottom quartiles represent the predicted probability that a firm repurchases its shares when the corresponding explanatory variable is set equal to the top and bottom quartiles of its respective distribution, respectively, and all other indicator (continuous) variables are set equal to zero (their sample means). For all indicator variables, implied probabilities for top and bottom quartiles represent the predicted probability that a firm repurchases its shares when the corresponding explanatory variable is set equal to one and zero, respectively, and all other indicator (continuous) variables are set equal to zero (their sample means)

41

Table 6 OLS regressions relating the value of shares reacquired in a given fiscal year to measures of underpricing, investment opportunities, cash holdings, gearing and a vector of control variables. The model is estimated using all available firm-year observations between January 1995 and December 2000 for firms undertaking at least one open market share repurchase during this period. The value of shares reacquired (COST) is equal to zero in firm-years where no shares are acquired, otherwise it is equal to the aggregate cost of shares bought during fiscal year t scaled by total assets at the beginning of year t. Probability values (two-tailed) are reported in parentheses.

Model:a

tjtjtjtjtjtj

tjtjtjtjtjtj

ACTPAYOUTDISTLOSSEPS HILEVCASHMTBNRETNRETCOST

,,101,91,81,71,6

1,51,41,31,2,10,)ln(

εδδδδδδδδδδδ

+++++∆++++++=

−−−−

−−−−

Full sample Trimmed sample Variable Model 1 Model 2 Model 3 Model 4 Model 5 Intercept -32.912 -36.059 -36.158 -34.799 -35.672

(0.001) (0.001) (0.001) (0.001) (0.001) NRETt 0.251 1.513 0.485 1.917 0.416

(0.744) (0.042) (0.629) (0.017) (0.712) NRETt-1 3.335 2.566 3.129 2.712 3.613

(0.001) (0.001) (0.002) (0.001) (0.001) MTB -0.371 -0.440 -0.275 -0.641 0.024

(0.038) (0.011) (0.444) (0.033) (0.960) CASH 11.685 13.189 11.978 12.467 14.321 (0.001) (0.001) (0.060) (0.003) (0.093) HILEV -0.864 -0.909 -0.982 -0.837 -1.628

(0.292) (0.253) (0.343) (0.328) (0.156) CASH × NRETt − − 9.207 − 13.996

(0.123) (0.058) CASH × NRETt-1 − − -5.152 − -8.360

(0.390) (0.258) CASH × MTB − − -0.620 − -3.559

(0.589) (0.067) CASH × HILEV − − 1.314 − 9.603

(0.871) (0.298) ∆EPS − -0.012 -0.012 -0.251 -0.197

(0.773) (0.778) (0.464) (0.564) LOSS − -3.218 -3.114 -4.045 -3.826

(0.020) (0.025) (0.037) (0.048)

DIST − 0.717 0.840 0.600 0.983 (0.658) (0.607) (0.768) (0.630)

PAYOUT − -0.107 -0.108 -2.149 -2.025 (0.456) (0.452) (0.043) (0.056)

ACT − 8.808 8.783 9.286 9.257 (0.001) (0.001) (0.001) (0.001)

Adj-R2 0.025 0.108 0.108 0.1131 0.1173 F 6.235 16.061 11.694 14.72 11.21 N 1243 1243 1243 1077 1077

42

43

Table 6 (continued) a The dependent variable is the natural logarithm of the cost of shares repurchased scaled by beginning-of-period total assets. To avoid generating missing values, we redefine COST as being equal to 0.00000001 in years where no shares are acquired. Explanatory variable definitions are as follows: NRET is an indicator variable taking the value of one if the 12-month excess return is positive and zero otherwise, MTB is the unlevered market-to-book ratio market value of equity, CASH is the ratio of cash and cash equivalents to total assets, HILEV is an indicator variables taking the value of one if net leverage is above the sample median and zero otherwise, ∆EPS is earnings per share growth, LOSS is an indicator variable taking the value of one if reported earnings are negative and zero otherwise, PAYOUT is the dividend payout ratio, SIZE is the natural logarithm of total assets, DIST is an indicator variable taking the value of one if reserves are positive and zero otherwise, and ACT is an indicator variable taking the value of one for fiscal year-ends after April 1999 and zero otherwise. Further details of all variables (including Datastream item codes) are reported in table 2. With the exception of NRETt, all variables are measured over the fiscal year preceding the repurchase year (t-1).